Tax Notes ran a letter to the editor this week penned by S-Corp President Brian Reardon. It responds to a recent critique of the Section 199A deduction and serves as a useful “cheat sheet” in rebutting the various claims we’ve seen over the years.

The first is that extending 199A will add to the deficit. As the piece points out:

The deduction was packaged with numerous tax hikes — the state and local tax cap, the excess loss limitation, the interest deduction cap, and others — that target upper-income business owners. Many of these pay-fors stay in the tax code even as section 199A expires, which would result in a significant tax hike on passthrough businesses.

The use of the word “significant” here isn’t just hyperbole. Because many of those revenue raisers are permanent, the loss of Section 199A would lead to a large tax hike on Main Street businesses, not relative to current law but rather to the pre-Tax Cuts and Jobs Act code.

The second critique centers on the notion that upper-income taxpayers disproportionately benefit from 199A. Here’s the response:

Large passthroughs do get the section 199A deduction, but only if they employ lots of people or make significant investments. That’s because section 199A imposes so-called guardrails on large passthrough businesses, so, for example, they only get the deduction up to 50 percent of the W-2 wages they pay. A 2019 Treasury study shows how these guardrails exclude about 40 percent of their income from the section 199A benefit, while a recent Congressional Research Service report observes that the section 199A deduction is neutral with regard to progressivity.

What’s portrayed as some sort of smoking gun is the natural consequence of a tax structure where business income shows up on a taxpayer’s individual return. Per Treasury’s own estimates, four out of five taxpayers with incomes exceeding $1 million were business owners. Furthermore, as a recent CRS report notes, “The Section 199A deduction appears to have little effect on vertical equity, as it does not appear to diminish the progressivity of the federal income tax.”

The same cannot be said for the corporate rate cuts. According to the Urban-Brookings Tax Policy Center, the corporate rate cuts primarily benefited upper-income taxpayers and detracted from the code’s progressivity. Anyone looking for “tax cuts for the rich” should start on the corporate side of the tax code.

The third argument claims pass-through businesses are competitive without Section 199A. Based on countless conversations we’ve had with our members and others in the Main Street business community, that’s patently false. But don’t just take our word for it:

…effective rate estimates by Treasury, the Congressional Budget Office, EY, Robert Barro and Jason Furman, and Jason DeBacker and Roy Kasher…show that the Tax Cuts and Jobs Act resulted in rough parity between business forms.

If there is an imbalance, it goes the other way. The folks at Penn Wharton predicted that one sixth of all passthrough activity would shift to C corporations following adoption of the TCJA: “Prior to the TCJA, pass-through businesses were growing remarkably over time. We project that the TCJA will reverse this trend…” Keep in mind, this migration was supposed to occur with the section 199A deduction.

That claim also ignores perhaps the most salient feature of the ongoing tax debate – that most publicly traded corporation shareholders don’t pay tax. Why is that important? Because tax burden comparisons must estimate the burden of shareholder-level taxes. If 75 percent of corporate profits go to shareholders who pay little or no tax, then the overall C corporation rate is significantly lower than the advertised rate.

The good news is that the facts are on our side and we have a year to educate policymakers on why pass-throughs are critical to the US economy, and why Section 199A is important to these businesses.  More to come…